Monday, March 23, 2009

The road to hell is paved with good intentions . . . if by hell you mean total economic meltdown. Parts I & II.

Part I

I've had a lot of fun ridiculing social conservatives and leftists in my previous posts. In the spirit of fairness, I'd like to take a moment to tell a joke at the expense of all those hopeless political vagabonds who think like I do.

How many Libertarians does it take to screw in a light bulb? None. The market will take care of it.

Yeah, guys like me are always railing against the government. The government taxes me too much. The government destroyed health care. The government ruined education. The government spent too much money freeing a country that didn't really deserve it. I apologize to all my friends and acquaintances who have had to sit through one of my libertarian rants. I just can't help it. It’s like a super power: the uncanny ability to trace any societal malady back to some action of government. (I also have the power to extract sexual innuendo from any sentence containing a direct object, and it's by far the more useful of the two.) But sometimes they screw something up so thoroughly and so obviously (that's what she said), you don't need tights and a cape to see it. And, invariably, it begins with the best of intentions.

Take housing for instance. All government wanted was to allow more people to buy a home. (As you can see, I like to anthropomorphize government.) To that end, Fannie Mae was created as a part of the New Deal, and Freddie came along 1970. These untaxed “government sponsored entities” (GSE) paid their politically selected officers millions of dollars and made exorbitant political donations to the--mostly democrat--members of congress who were responsible for their continued funding and existence. Few cared that the reflexive quid pro quo created from this relationship encouraged rampant corruption (more on this later). What mattered to everyone is that government’s intentions were good: if a home buyer could show that he was able to afford a reasonable mortgage and could drop a 20% down payment, the government would ensure that his mortgage would be funded, using money government had taken from everyone else. (For purposes of this post only, when you mentally picture my anthropomorphized government, it should look like Grimace, the large purple mutant shake fiend from McDonald’s commercials; skipping through an idyllic McDonaldland, obliviously crushing the other denizens beneath his huge feet. Hereafter, you can go back to picturing government as a larger, more bloated version of Rosie O’Donnell.).

But what if you can’t convince your bank that you can afford to repay a home loan?

The Community Reinvestment Act (CRA) signed by President Jimmy Carter in 1977 forced banks to lend to borrowers who were not good credit risks. The CRA was a law perfectly crafted to advance the government's benevolent desire to make it easier to buy a home. Yet for almost 20 years the act wasn't really enforced. Why? It has been posited that executive-branch grunts tasked with CRA’s implementation simply chose not to do so, perhaps realizing how ill-advised it is to force banks to lend money to people who can’t pay the money back. But I think the reason is more likely that making loans to people who can’t repay them hadn’t been properly incentivized yet. In other words, there was no way to make a bad loan profitable, so lenders avoided doing so.

Hello President Clinton.

In an approach to loans described by then HUD Secretary Andrew Cuomo as race motivated “affirmative action,” the Clinton administration in the mid-nineties imposed high-risk minority loan quotas upon lending institutions. The Clinton administration then led the 800 pound GSE gorillas into the subprime mortgage market to “benefit lower income families” who otherwise could not obtain loans. Of course, the reason low-income folks used to have trouble getting a home loan was because there was a higher-than-acceptable probability that they could not pay it back. But now such loans had the imprimatur of the government treasury, and their value was therefore so far beyond question that they could be bundled--often with less-risky loans--to back securities traded on Wall Street. And the more such loans that could be handed out, the more of the mortgage backed securities could be produced. And all of a sudden there was money to be made on risky loans.

Around this time, the Clinton administration began to support lawsuits brought against lending institutions under the CRA. These lawsuits were settled for billions of dollars. But more importantly, lenders were terrorized by extortionist tactics of groups—like the infamous ACORN—seeking to prove that lenders were not complying with the CRA. And compliance with the CRA could be accomplished only one way: more risky loans.

Every externality was now driving lenders to make as many loans to as many poor credit risks as possible. But lenders weren’t feeling the deleterious effects of the bad loans. Why? Because everyone and anyone could get a home loan, causing demand for homes to shoot through the roof. Don’t believe me? Click below.

Look at the right side of the chart. From 1997 to 2007, there was such a steep increase in home values, it didn’t matter that one guy might default on his loan. Sure, the lender might be stuck foreclosing on a house, but he knows that someone else will buy the house tomorrow, when the damn thing will be worth thousands more. Besides, why would a mortgagee let his house get foreclosed when he can sell it himself for twice what he paid; or, rather, twice what the bank loaned him to pay for it?

This is when things really went crazy. When banks rely on housing prices in an eternal upswing, they can offer ridiculous things like no-down-payment loans, interest-only loans, adjustable rates, and loans to people with no income. Banks around this time would sooner have refused your kid a lollipop than turn down your loan application. And why would they? Let’s say I ask for a loan of 100,000 dollars to buy a 100,000 dollar house on whatever terms they were advertising that day. There is no need to check my income or credit history; if I default, the bank is left with a 100,000 dollar asset that will simply accrue value at an astronomical rate until they sell it again. And as long as every lender in town is looking to finance the next buyer, it can go on like that indefinitely. The lender can also rely on my built-in incentives not to default that arise out of the fact that my home will be worth more and more money as the years progress. And they get to count my subprime loan on their CRA compliance stat sheets.

This is approximately where we were when George W. Bush took his place on his father’s throne.

Part II

George W. Bush called his brand of governance “compassionate conservatism,” and, like the name implies, he had the best of intentions. That doesn’t make his administration an aberration, since most presidents take office with good intentions. LBJ intended to end poverty in America. Nixon wanted to keep the world safe for America. Carter wanted to keep the world safe from America. And even though Bill Clinton probably regarded the presidency as no more than a vehicle to having semi-consensual, quasi-sexual relations with some rather plain women, feminists are certain that his intentions were good. But Bush the Younger’s policy of using government resources to increase home ownership in poor and minority areas might seem peculiar because it seemed to stand in contrast to the principles of conservatism he championed. It was not.

If you have perused the rest of my blog you might remember that I once complained (well, more than once. if you read my blog, you know that I complain about something or other in every post. It’s sort of a theme.) that conservative principles only seem to remove government from your life if you work hard and raise a decent family. The Bush policy on low-income home loans was probably an extension of that principle, in that he believed owning a home ought to make poor folks settle down and work hard to stay out of foreclosure. Home ownership might even—-as the New York Times posited on December 20, 2008, without hint of sarcasm—-turn low income minorities into Republicans . . . . apparently because gaining a sense of responsibility and a willingness to work hard will make even the poor unfit for the Democrat party. (Don’t blame me for trafficking in these lurid stereotypes, blame those right-wingers at the New York Times.)

Whatever the reason, Bush wanted low income folks buying homes whether or not they could afford them. New housing developments rose with much fanfare--even personal visits from the president--in “blighted” areas, where home buyers of every income and race were eligible for taxpayer funded down-payments with adjustable rate mortgages. Unfortunately, incomes could not keep up with the astronomical rate at which housing prices were climbing. This--coupled with all the stupid policies preceding Bush that were still in place--led to more risky lending behavior in order to drive more sales, which pushed housing prices even higher, meaning even fewer people could afford new mortgages, causing more risky lending behavior, leading to higher housing prices, then fewer qualified buyers, followed by more risky loans, ad infinitum. Actually, not infinitum. More like about 11 years.

That's about when the adjustable rates went up, and some interest-only payments became bloated-interest-plus-principle payments. And then houses began to go into foreclosure. These were mostly the houses bought by people who couldn't afford them to begin with. If your income is high enough to take a real mortgage, why would you accept and ARM or an interest only mortgage? You might as well take a rent-to-own, or a payday-loan, or pawn something.

All of a sudden, there was an excess of homes on the market, and housing prices dropped. Without a large down payment, there was no stake to keep the more-recent buyers in their homes, especially the flippers and speculators. Many simply accepted foreclosure over making payments on a depreciated asset. Excess became glut, and the bottom fell out of the market. All those mortgage backed securities lost their value, Fannie and Freddie fell apart, and it's brother-can-you-spare-a-dime all over the place.

Bush apologists are quick to point out that he saw that Fannie and Freddie were ripe for disaster in 2002. They say he tried to do something about it several times, only to be rebuffed by the Democrats in the House of Representatives. And it's true that Barney Frank and the rest of the pimps on the House Financial Services Committee bear the blame for the collapse of the GSE's. Even the New York Times recognized Bush's prescience and lack of culpability in the hit piece it put together to blame everything else on him. But if Bush saw the underlying problem, why did his administration continue to push home ownership on anyone who could grip a pen?

"We absolutely wanted to increase homeownership,” Bush says. “But we never wanted lenders to make bad decisions.” Well if Fannie and Freddie were in the kind of shape his administration warned, then what other kind of decisions are there? None. Bush, like Clinton, pushed lenders over the edge. He can't say now that he didnt think they'd fall.

But I guess we shouldn't blame him. I mean, his intentions were good.


  1. 4 comments:
    halliewiseley said...
    Excellent, excellent, excellent. Will the saga continue next week? I am just dying to read more about the adventures of the villainous Grimace Government.

    March 16, 2009 12:21 AM
    K said...
    Good stuff -- I will comment later when I have to compose ... :-)

    March 16, 2009 8:54 AM
    Tina, Ball Team Co-Captain said...
    What a cliff hanger. I will read the pape today to peek at how this story is going...

    March 16, 2009 2:37 PM
    Internet Strategist said...
    I am glad to see that you mentioned corruption as one of the main causes. Another is who benefits from changing the laws and regulations. Follow who will end up with the money and you'll find the true cause.

    Major mistakes are ALWAYS easily predicted because they are preceded by changes that make what will happen obvious:

    If you guarantee Savings & Loans that the government will repay their bad loans are you really surprised to get the Savings and Loan crisis?

    If you change how Executives are paid from being based on REAL PROFITS generated by their companies to the value of their stock are you really surprised their creative accounting and stock market games brought us Cash Pensions, corporations selling off valuable assets, eliminating positions, sending jobs offshore, and much more?

    When will we stop rewarding corruption and writing books about those who have enough sense of timing that they can pocket the assets of a Corporation and exit so that the next executives get left holding the bag and getting the blame?

    Who benefited from the fiasco you're covering now? Is government in charge or just another pawn in the game too?

    March 17, 2009 8:30 PM

  2. Great post. Filled with marvelously witty views of the tragic failure of our government to govern within confines of the law. Always glad to find another Wiseley. Delighted that you can think for yourself and write such good common sense material.